Availing a Loan against your Life Insurance Policy – What you need to know

There are a few things that you may need to consider before you take a loan against your policy.

Instead of taking a personal loan or a loan against your credit card, you can opt to borrow from your insurance policy if you are in need of emergency funds.

The main purpose of a life insurance policy is to provide the policyholder a risk cover against death. However, in order to make life insurance a more viable option to customers, more and more insurers have started to provide life insurance solutions that offer other attractive benefits as well. One example of this is providing policyholders the option to avail a loan against the cash value attached to a life insurance policy. Thus, instead of taking a personal loan or a loan against your credit card, you can opt to borrow from your insurance policy if you are in need of emergency funds. However, before you take a loan against your policy, here are a few things that you may need to consider.

Are you eligible to avail a Loan against your Life Insurance Policy?

Firstly, you will have to remember that not all life insurance policies offer policyholders the option to avail a loan. Traditional term insurance policies, for example, do not give policyholders this benefit since they have no cash value. However, life insurance plans that have a cash value or surrender value linked to them provide policyholders this added benefit. Thus, you will first need to check if your insurance policy offers this feature, and also if your policy has acquired a surrender value. Policies that have just been purchased will not have a surrender value. Your insurance policy will only acquire a surrender value if you have paid the premiums consistently for a few years. It is also important to remember that this benefit is solely applicable to life insurance products. Health insurance plans and motor insurance plans do not offer this option to insured members.

Loan amount and Rate of Interest

Most insurers will not allow you to take a loan on the policy’s full surrender value. Typically, insurers will allow policyholders to avail a loan amount that is between 60% - 85% of the policy’s surrender value. Also, since your loan amount is not considered a source of income, it will remain tax-free. It is important to note that once a policyholder has availed a loan against his or her policy, the rights of the policy will be transferred to the lender. Like the loan amount, the rate of interest will also vary from insurer to insurer. Interest rates usually range between 10% - 15%, based on the lender.

Repaying your loan

The exact terms and conditions of repaying your loan will usually vary based on the lender. Most borrowers are provided the option to pay back only the interest or the interest and principal, as instalments. In case one chooses to pay only the interest, the principal amount will be deducted from the death benefit that will be paid to one’s nominee or from the maturity benefit. However, it is recommended that you pay both the interest and the principal in order to keep the cash value of your policy intact. Hence, when a payout is made in due time, you or your nominee will be eligible to claim the entire amount as opposed to being paid just a fraction of the benefit.

What you should consider before taking a loan against your policy?

Opting for a loan against your insurance policy is a hassle-free process when compared to availing a traditional personal loan since the repayment terms are more flexible and the documentation process is also much simpler. However, one must remember that the main purpose of a life insurance plan is to provide a payout in case the life assured meets with an untimely death during the policy tenure. This payout can go a long way in securing the lives of one’s dependents, in the absence of a steady source of income.

Thus, when you take a loan against your life insurance policy, you are essentially putting your dependents at risk. If the policyholder passes away during the policy tenure, the insurer will simply deduct the outstanding loan amount from the payout, and only pay the remaining balance to the nominee. Based on your loan amount and the cash value attached to your policy, this payout may or may not be the amount that you envisioned when purchasing a policy.

Availing a loan against your life insurance policy might seem like an attractive option, but it can make a significant difference to the lives of your dependents. In the end, if taking a loan against your insurance policy seems like the best option, ensure that you speak to an insurance advisor in order to better understand the terms and conditions of the loan and also the short-term and long-term risks attached to it.